Government Policy, Not Laziness, Responsible for Scaring Away Foreign Investors

2 Dec 2011

President Obama recently told a group of CEO’s that America had “been a little bit lazy” about “selling America and trying to attract new businesses into America.” Is this the case, or has the quality of the product simply declined? America’s descent in the Heritage Index of Economic Freedom would certainly tend to suggest that it’s the latter. The reality is that laziness is not to blame for any increasing unattractiveness to foreign investors; government policy is.

There are two looming policies, in particular, that are threatening foreign investment in the US. One of those is the Foreign Account Tax Compliance Act (FATCA), passed in 2010 in an effort to raise revenue for the HIRE Act through greater tax enforcement. The other is an IRS proposed regulation which would require reporting of interest payment information on foreign depositor accounts, despite the fact that the US has no use for the information. Both policies are misguided, counterproductive, and will drive investment out of the US.

FATCA is designed to compel foreign financial institutions to become deputy tax collectors for the IRS. By 2014, these institutions will be expected to have implemented expensive new data collection and reporting systems, and those that have not complied will face a 30% withholding tax on US source payments to the institution. As if those costs aren’t enough, FATCA also conflicts with local privacy laws in many countries, placing FFIs in an impossible position. Already, institutions are deciding that it makes more sense to simply drop their US clients and disinvest in US markets than to continue jumping through IRS hoops. The result is billions in lost foreign investment, and there is only more to come.

The FATCA legislation is the product of a misguided school of thought within the US political class which believes that there are vast sums of unpaid taxes which the IRS would be able to collect if only the rest of the world would stop hiding it from them.

…The rationale behind FATCA is simple in its destructiveness. Even though the US has a very high compliance rate for tax laws compared to the rest of the world, US politicians decided that more enforcement was needed to get more money to fund more spending and bigger budgets in Washington. Throwing aside any semblance of cost-benefit analysis, they then decided to spare no expense to capture every last dollar of potential tax revenue. Unfortunately, FATCA was not a wise approach. Ordinary Americans will suffer from the ensuing damage to the economy. Foreign financial institutions will endure higher regulatory burdens and compliance costs. And the FATCA law creates a powerful disincentive for foreign investment in the US. FATCA thus has the net impact of potentially reducing both economic prosperity and government tax revenues.

The other policy disaster on the horizon is a regulation proposed by the IRS which would require domestic banks to collect information and report on the interest payments made to foreign depositor accounts. The IRS would then share this information with foreign regimes. They assure us that sharing would only take place with countries that have tax treaties with the US, but that list is not only capable of changing at any time, but already includes the dictatorship in Venezuela, and crime and corruption plagued Mexico. What’s more, these payments are not taxable under the US tax code – a policy which Congress has explicitly chosen in order to foster foreign investment in the US – and so the rule serves no direct domestic interest.

A recent Congressional hearing I attended on the issue covered a variety of arguments against the regulation. Members were concerned about the human rights implications for foreigner depositors, particularly from Latin America, who face kidnapping and extortion threats back home, but most importantly the capital flight this concern would cause should the rule pass. Years ago, the Mercatus Center did a study estimating $88 billion in lost foreign investment. That was on rule more limited in scope, so today’s proposal would be even more destructive.

The tax bureaucrats seem intent on plowing forward, even as Congress is mobilizing against the IRS on the issue (bills to prevent the rule from being implemented have been introduced in both the House and Senate – thanks to the leadership of Florida Rep. Bill Posey and Sen. Rubio, as well as Texas Senators Hutchison and Cornyn – and have a combined 28 co-sponsors). The IRS’s objective quite likely is to please foreign tax collectors who are complaining loudly about the burdens we are demanding their institutions take on with regard to FATCA.

President Obama thinks we have been lazy in selling America. But his administration has been anything but lazy in making America a harder sell to foreign investors. Rather than compound the mistake of FATCA with another one, while simultaneously driving out much needed foreign investment, we should revisit the initial legislation and look instead at making the tax code less complex and more economically competitive. Then we should tell the IRS that their job is only to enforce US tax laws, not to take it upon themselves to decide that America’s interests are outweighed by the tax information demands of the likes of Hugo Chavez.